Pensions time bomb: Save early, get ahead of global age trends

State pensions are creaking under the weight of Ireland's ageing population, heading towards a two-to-one ratio of workers to retirees

Save early, feel better: Finance decisions are by far the biggest cause of anxiety among Irish adults, a far higher concern than worries about chronic illness.

A report from Japan recently revealed that over 107,000 of its citizens are aged one hundred years or older. The comparative figure in Ireland is just over a thousand. 

While it would obviously be unwise to draw any specific scientific conclusion from such slender data points, it might be an indicator that eating raw fish and steamed vegetables is better for your longevity than eight creamy pints and a late-night spice bag on the way home from the pub. What is empirically proven is that irrespective of prevailing lifestyle norms, in every part of the world more and more people tend to stick around for longer than was previously the case.

This comes with a massive price tag, and this changing age demographic is a headwind that all countries are currently tacking into. In Ireland for instance, there are currently four workers subsidising every state pension, in the not-too-distant future this ratio will be two to one. Without innovative policy, in order to maintain the status quo, either the treasury allocation to pensions doubles or the payout must be halved. Neither of these options will be politically possible.

This is the reason behind the two headline countermeasures launched this year, the MyFutureFund and the State saving and investment account. Despite all the marketing fanfare and an avalanche of earnest ministerial explanations across the media, these innovative financial products still look arid and uninteresting to most citizens under thirty years of age. A more direct approach should have been taken with the messaging that properly conveys the panic in the Department of Finance.

Save now, for God's sake, before it's too late 

The message needs to be unequivocal as the success of such aggregate macroeconomic policies will sink or swim based on the micro decision-making tendency at the individual level. But recent surveys indicate that personal finance decisions are by far the biggest cause of anxiety among Irish adults. To put this into sharper context, worries about chronic illness are down at number seven.

Two pensions decisions carry a unique burden of tyranny for most people. When to start and how much money to accumulate to enable retirement aspirations? And then sometime in the far-off future, what is the best way to ‘decumulate your pension fund? 

Behavioural scientists are currently spending plenty of academic capital studying the impact of these decisions on individuals. Pensions by design are a dry, rational actuarial calculation with the answer always expressed as an unemotional number. Human beings in contrast are wet, irrational, and emotional by nature. Pension draw down choices are where dry and wet worlds collide. Unsurprisingly, the Nobel prize winning economist, William Sharpe has described the decision to decumulate as the ‘nastiest, hardest problem in finance.’ 

Greg Davies, head of Oxford Risk, says that sound financial planning helps to drastially reduce people's stress.

 Greg Davies, who heads Oxford Risk, a London-based fintech company founded by a group of behavioural scientists from Oxford University, put this dilemma concisely in an interview last year when he said: “Retirement isn’t just a financial shift – it involves a series of emotionally charged high-stakes decisions. Yet many people reach this point under-informed, anxious, and without the structured support they need.” 

Henry's retirement plan

The outcome is often decision paralysis. Take a constructed example; a man, let’s call him Henry for convenience, has just retired from private industry at the age of sixty-six. His house is fully paid for, and his retirement ambitions are modest. A solid private health care plan, winter on the Costa Brava with the menu ‘del dia’ with a nice glass of rioja for lunch. A warm home and colourful garden the rest of the time.

Henry worked in payroll for forty years and was always careful with his money. He understood that the value of assets compounded so he maximised his additional voluntary contributions (AVCs) and he now has a pension fund not far off a respectable lottery win. But he just can’t make up his mind what to with it and the tyranny of the decumulation decision and it’s close relation, the tyranny of choice, is keeping him awake at night.

Should he convert to an annuity or approved retirement fund (ARF)? What level of equity risk should he choose, low, medium, or high? Lump sum now, lump sum later or lump sum never? What is the percentage of monthly draw down from his fund that maximises his life quality, protects the continuing value of his fund and minimises tax liability? Are the funds charged by his pension provider reasonably competitive? Rent or buy in Spain? How about a new car? Will the tax rules on pension income tighten?

All this internal noise and that’s before he even broaches the anxieties outside of his control. Will geopolitical chaos lead to hyperinflation and devalue his investments? Are trade wars and tariffs likely to negatively impact the value of the equities and commodities in his portfolio? Will the Irish government be able to maintain state pension levels if the multinational tax bonanza uproots and heads back home. 

No wonder poor old Henry is walking around with bags under his eyes. Like many pension holders at this point of the decision, he is considering just turning his whole pot into cash and depositing into his current account and hoping it sees him out. He feels it would be a lot simpler and less worrisome even though he knows that this would be unwise.

Happily, the auto-enrolment aspect through MyFutureFund is showing strong early signs of success and will help solve some of the ‘accumulation decision problem'. Over 800,000 employees are already participating and only a 1% dropped the plan when the opt out window opened. Decisions, it seems, are less tyrannical when somebody else makes them for you.

But Henry’s inertia in the decumulation decision remains unresolved, although it is being increasingly recognised by both governments and the global pension industries and mitigation steps may be afoot. A recent study by the Department of Work and Pensions in the UK asked two critical questions; What factors do people consider when making decumulation decisions, and why? How do those factors influence their decision-making?

Overall, respondents felt that improving understanding, capability and access to trusted support would help them make more informed decisions. Their biggest concern was an absence of clear and simple information, personalised for their needs, that information be delivered in plain unadorned language, and financial education provided earlier in the pension cycle.

The recommended policy and practice adjustments recommended from the study are hugely relevant the Irish experience. Notably, supporting earlier and more sustained engagement with pension planning from an early age. Targeted support for people like Henry to address his capability gaps around decumulation choices. Reduction on choice overload. Targeted education beginning at secondary school that supports long-term decision-making and not just point of access or point of decumulation choices.

Understandably, it’s difficult to build a meaningful and enduring solution to complex and tyrannical decisions. But urgency is crucial. Japanese restaurants are opening everywhere and Ireland’s appetite for sushi is booming. The beloved spice bag is under pressure.